Dont Forget Momentum

Trading the trend is something that virtually every trader is told to do. It makes sense because it stands to reason that getting on a position in the main direction of the market can rack up the money.

The issue then becomes:

• How to identify the trend so you can trade that direction
• Determining if trend is about to turn because it’s run the course

Not an easy things to do.

Every trend indicator uses past price so they are always going to be one step behind. As well, waiting for a trade in the direction of the trend can keep you on the sidelines until price reaches your area of interest.

There are also different trends on different time frames. I’m sure you’ve heard “if you ask what the trend is, the answer is what time frame are you referring to?”.

Over the years, one of the biggest issues I’ve seen is people being simply confused on which direction to trade.

Higher Time Frame Trend

One of the popular methods of trading is determining the direction of the trend on a higher time frame such as the weekly; and then trading that direction on the daily. Taking a look at two popular trend determination tools you will see that we have some conflicting information.

1. Trend lines are used in a fanning way to accommodate swing levels.
2. This is a 50 SMA and we can use either the slope of the line for direction or price relation to the average.
3. This trend line makes things interesting as the average says short, this line says long plus there are a few directional chart patterns in this area.

The bottom line is there is some controversy on our overall price direction when it comes to the point where the price trend runs out of steam.

Price Momentum Plan

One idea I’ve used over the years is using price momentum as a basis for direction and even for triggering a trade.

Think of momentum like a car on a hill. Don’t think of the direction of the car but look at how fast the car is tackling that hill. As the hill gets steeper, the car starts to slow down.

For trading, momentum is simply how fast the trend of price of moving or “Rate of Change”

Note: There is an indicator called Rate of change or ROC but that will not be introduced in this trading piece.

When using momentum remember to keep it apart from the price trend. The momentum reading is about the momentum trend. You won’t always see price turn when the indicator turns unlike trend indicators.

You can actually have price moving up and the indicator moving down as the momentum or change in price is slowing down. (this is not a bad thing either).

1. Price continues to advance upwards and not while not labeled, the 50 SMA says uptrend.
2. Momentum indicator indicates a decline in price momentum even though the trend is up.

With this one example you can see that the price is not making strong moves and even though trend is up, the fact that momentum is going the opposite way can keep you out of trades on this time frame.

What about trading the price momentum direction of the higher time frame on the lower time frame?

Can you have a trading plan that let’s you take advantage of different stages of the trend by using momentum?

Counter Trading Daily Price Momentum

Due to space restraints, I can’t break down the daily chart of the following hourly chart. What you should know is that using the moving average, the daily remains in an up trend. Using a trend line, the trend is up until it breaks which I will show in this chart.

The green line on the left shows where the daily momentum rolls over to bearish. The red line indicates where the daily momentum rolls over to the trend direction of bullish.

1. The trend channel highlights price action that offers trading opportunities depending on your style of trading. There are mini pullbacks and range breaks throughout the move.
2. This highlights the price level where the daily trend line breaks. There are no retests of the broken trend line on the daily chart.
3. Highlighting price action that gives you the retest off the daily zone but multiple moves to the downside.

The yellow circle is interesting as it occurs after a large move after the trend line break. Many traders would treat this as a bullish move and look to position on a retest. The retest shatters the line. As well, very often after a strong move, consolidation near the highs are trading opportunities for further upside moves.

None of that occurs as we sit in a down trend of daily momentum while the trend is bullish

At the red vertical line, we get daily price momentum turning to the upside and we could be on alert to find setups to get us into the daily price trend.

You often hear the counter trend trading is a fools game but here, we did didn’t blindly take counter trend trades as we needed to see momentum drifting from the up trend.

There is a much better use for price momentum and that is when all signs point in one direction.

Trend And Momentum Match

If we combine the momentum and trend, then we have a potential 1-2 punch for our trades.

This chart takes up where the previous one left off. The daily chart just had it’s momentum swing in the direction of its trend and now we look to take advantage of this powerful combination.

The green line is where daily momentum turned and the red line is where the daily momentum turned bearish.

The trade setups are simple and in order to have some degree of non-bias, I moved the chart forward step by step and reacted as it played out:

• Flag breakouts and structure inside the flags
• Consolidation at the top of strong moves
• Pullbacks to areas where price either rockets from or to areas where the move to break the down trend line originated

You can see the move up in this chart runs pretty strong and knowing you had trend and price momentum supporting your position can help you stay in your position longer.

Having the momentum on your side is just part of the puzzle. It just sets the potential that a trading opportunity may be possible depending on your method of trading. Even using this powerful trading combination, you still need your trade setup + trigger to actually have a trade.

Whatever method you trade now, try to incorporate the information in this trading post to see if it is something that proves useful.